Founded in 1993 by brothers Tom and David Gardner, The Motley Fool helps millions of people attain financial freedom through our website, podcasts, books, newspaper column, radio show, and premium investing services.

A Secured Credit Card Can Be The Solution To Bad Credit

A secured credit card could do a whole lot for your credit score, without the terrible rates and fees of other "bad credit" products.

If you are among the millions of Americans with bad credit, odds are that you have a tough time getting a credit card, if you can even get one at all.

pixabay/ jarmolux

There are several options here. You can choose to wait it out until the bad information to fall off your credit report, which can take up to seven years. You could choose a credit card specifically designed for people with bad credit, which can end up costing more than its worth. Or, you could choose to get a secured credit card, which can benefit your credit and personal finances in several ways.

How secured cards workA secured credit card work just like any other major credit card. You can use it at any retailer who accepts that particular type of card (Visa, MasterCard, etc.), and you can also use it to pay for goods and services that require a credit card hold, such as renting a car or staying at a hotel.

The only real difference is the "secured" part. In order to receive your new credit card, you are required to deposit money into an account with the issuing bank, generally in an amount equal to your desired credit line. So, if you deposit $500, you can get a $500 credit limit. Sure, it requires a substantial amount of cash, but unlike traditional "bad credit" cards, the money you put up remains yours, and will be returned to you when you close the account.

A secured credit card reports to the three major credit bureaus, and lenders will have no idea that it's a secured card. It will look just like any other credit card listing, with a payment history, credit limit, and balance information. This can be the best feature of a secured card, and I'll get into the specifics on how it can impact your credit score a little later.

So, how do you choose a secured card?

The best optionsThere are several options to choose from here. Basically, you want a card with a low annual fee and the lowest interest rate you can find. Ideally, you'll also find a card that will add to your credit limit as you establish a solid payment history.

Source: company

For example, the Wells Fargo Secured Card charges a $25 annual fee and currently has an interest rate of 18.99% which will change with the market. This is pretty close to the terms you can expect from a standard "good credit" card. You can deposit any amount from $300 to $10,000, and your initial credit line will be the same as the deposit amount. The bank reviews accounts periodically and cardholders with a solid payment history may become eligible for an unsecured card. The card has some other useful benefits, such as using it for overdraft protection on a Wells Fargo checking account and free access to online credit education.

Other products from Capital One and U.S. Bank have similar terms and benefits, so choose the card with the best benefits for your situation. In addition, U.S. Bank has several secured credit card products that offer rewards through partners like Harley Davidson and AeroMexico. These have slightly higher interest rates than the bank's basic secured card, but depending on how much you'll use the rewards, it may be worthwhile.

There are plenty of other secured credit cards to choose from, so do your research. Your own bank is a good place to start the search, as many offer the ability to link bank and credit accounts together.

How much of a difference can it make?As long as you use the card responsibly, having a secured credit card can make a huge difference in your credit score, and the effects might be seen quickly. For example, 30% of your FICO score (the score lenders look at) comes from the amounts you owe on credit cards relative to your balance. Well, if you currently don't have any credit cards, this is an untapped portion of your score. As long as you keep your balance low (say, less than 20% of your limit), a secured card can really help this category.

Another 10% of your score comes from the types of credit you use. Essentially, lenders want to see a diverse mix of loans, credit cards, and other accounts. If you don't have a credit card right now, this category is not helping your score as much as it could.

And over time, other categories such as payment history (35% of your score) and length of credit history (15%) will benefit.

The bottom line here is that having a credit card in good standing is essential to establishing and maintaining better credit, and a secured credit card is a cost-effective and very beneficial way to get one.

Author

Matt is a Certified Financial Planner based in South Carolina who has been writing for The Motley Fool since 2012. Matt specializes in writing about bank stocks, REITs, and personal finance, but he loves any investment at the right price. Follow me on Twitter to keep up with all of the best financial coverage!
Follow @TMFMathGuy